Dimitris Papanikolaou

Investment Shocks and Asset Prices

I explore the implications for asset prices and macroeconomic dynamics of shocks that improve real investment opportunities and thus affect the representative household’s marginal utility. These investment shocks generate differences in risk premia due to their heterogeneous impact on firms: they benefit firms producing investment relative to firms producing consumption goods and increase the value of growth opportunities relative to the value of existing assets. Using data on asset returns, I find that a positive investment shock leads to high marginal utility states. A general equilibrium model with investment shocks matches key features of macroeconomic quantities and asset prices.

Winners and Losers: Creative Destruction and the Stock Market

We analyze the effect of innovation on asset prices in a tractable, general equilibrium framework with heterogeneous households and firms. We argue that financial market participants are unlikely to capture all the economic rents resulting from innovative activity, even when they own shares in innovating firms. This argument is based on two insights. First, investment opportunities are partly embodied in people -- in the form of new ideas, inventions or business plans. Consequently, part of the benefits from technological progress accrues to these innovators rather than to the shareholders in the firm. Second, while capital is typically tied to a specific technology, labor is more flexible, since workers have skills that are often transferable across technologies. We formalize these insights in a general equilibrium model, which we calibrate to the data. Our model reproduces key stylized facts about asset returns and the economy. We derive and test new predictions of our framework using a direct measure of innovation. The models predictions are supported by the data.We develop a general equilibrium model of asset prices in which the benefits of technological innovation are distributed asymmetrically. Financial market participants do not capture all the economic rents resulting from innovative activity, even when they own shares in innovating firms. Economic gains from innovation accrue partly to the innovators, who cannot sell claims on the rents that their future ideas will generate. We show how the unequal distribution of gains from innovation can give rise to a high risk premium on the aggregate stock market, return comovement and average return differences among firms, and the failure of traditional representative-agent asset pricing models to account for cross-sectional differences in risk premia.

Equilibrium Analysis of Asset Prices: Lessons from CIR and APT

The Cox, Ingersoll, and Ross (CIR) model proposed a framework for asset pricing in general equilibrium, introducing an explicit description of the macroeconomy into a model of financial markets. The research program started by CIR has been influential and remains highly relevant. In this article, the two authors, both doctoral students of Professor Stephen Ross and one later his colleague at MIT, summarize how the seminal contribution of CIR has seeded their own academic work, with a particular focus on equilibrium analysis of cross-sectional patterns in stock returns.